Weekly View - Slower, higher…and longer
The Fed’s decision last week to hike by 75bps was expected. But while Fed chairman Jerome Powell hinted strongly at a slowdown in the pace of tightening, he also suggested the current terminal rate of 4.6% for the fed funds rate set out in the Fed’s ‘dot plot’ projections may need to be revised higher (the market is now pricing a terminal rate close to 5.2% by mid-2023). So, the path of rate rises may be slower—but longer and higher as well. Also last week, the Bank of England increased its policy rate by 75 bps to 3.0%, while headline inflation in the euro area reached an annual 10.7% in October (up from 10% the previous month). European Central Bank president Christine Largarde said that recession alone may not be enough to tame inflation, signalling further rate hikes ahead. We are therefore underweight the debt of the more vulnerable euro area countries.
Marked by further earnings disappointments and downward revisions to 2023 estimates, equities put in a mixed performance last week. In the US, an increase in unemployment and a decrease in the growth of average hourly earnings prompted a partial reversal of last week’s gains for the US dollar. But amid the earnings disappointments, Q3 results in the oil sector have been tremendous, with companies increasing dividends and buybacks. We are thus positive the oil sector.
Purchasing manager indexes paint a varied picture of economic activity in Asia. But Asian equity markets rose last week (the MSCI China bounded ahead by 11% in USD terms) on rumours that China’s ‘zero-policy’ policy was about to be relaxed. Alas, China’s State Council has dashed hopes of any such change. A positive development was KKR’s success in raising nearly USD6 bn for its second Asia Pacific infrastructure fund, which confirms our positive stance on private assets. Chancellor Olaf Scholz's one-day (!) visit to China was an indication of how far Germany’s economic fortunes are tied to China’s. It also raised fears that Berlin was putting its own interests before those of Europe as a whole. By helping prevent the worst tail-risk event, the joint statement issued by Scholz and Xi Jinping against the use of nuclear weapons in Ukraine is positive.
Brazil has healthy economic fundamentals, yet its chronic current-account deficit and high public debt will constrain the new administration of Lula da Silva, who also will have to work with a divided, right-leaning Congress. We see limited upside for the Brazilian real. The centre piece of this week be the US mid-term elections, with ‘SAFE’ (security, affordability, fairness and education) the acronym doing the rounds among voters. The Democrats look vulnerable because they are hoping voters believe what the Biden administration says rather than believe their own eyes. Demands for richer nations to help emerging economies to transition to renewable energy will be central to COP27 proceedings in Egypt this week.